[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

fact, a process with a physical trail. Deposits are created by making entries in
records; today, electronic impulses create these records in computer files. The rules
of deposit creation, which specify when certain entries can be made in these files—
in particular, the fractional reserve requirements—also give rise to the system’s
ability to expand deposits by a multiple of the original deposit increase.
The money multiplier provides the link between the quantity of reserves in the
banking system and the quantity of money. However, we have not yet explained
where reserves come from. What determines the quantity of reserves, and therefore
the money supply? To answer this question, we need to look more closely at
the behavior of banks and the behavior of the Federal Reserve.
Wrap-Up
MONEY MULTIPLIER
An increase in reserves leads to an increase in total deposits by a multiple of the
original increase.
If the reserve requirement is r percent, the maximum increase in deposits will be
1/r times any increase in reserves.
The Federal Reserve
We have already learned that the Federal Reserve serves as a bank for banks and
that it sets the reserve requirement that determines the money multiplier. But the
Fed’s role in the economy extends much further. Federal Reserve decisions affect the
level of reserves in the banking system, the money supply, and the rate of inflation.
Learning about the tools the Fed can use and how they affect the supply of money
is important for understanding the behavior of money and prices.
Our focus remains on the economy at full employment. As we will see in Part
Seven, when the economy experiences fluctuations that lead to cyclical unemployment,
the Federal Reserve plays an important stabilizing role. Like most central
banks in the major industrial economies, the Fed has, in recent years, used its policy
tools to influence the level of market interest rates rather than attempting to
control the supply of money. Chapter 32 discusses how that influence is wielded.
The Federal Reserve is the central bank of the United States. A central bank is
the government bank that oversees and monitors the rest of the banking system,
serves as a bank for banks, and is responsible for the conduct of monetary policy.
In Canada, the Bank of Canada is the central bank; in the United Kingdom it is the
Bank of England; in the twelve-member European Economic and Monetary Union,
it is the European Central Bank; and in Mexico, it is Banco de Mexico. A nation’s
central bank often functions largely to regulate commercial banks. The Fed’s most
important role, in contrast, arises from its responsibility for the conduct of monetary
policy and the influence it has on the level of nominal interest rates and the
supply of money.
626 ∂ CHAPTER 28 MONEY, THE PRICE LEVEL, AND THE FEDERAL RESERVE